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Related Party Transactions: A Second Source for Earnings Management – Evidence from Chinese IPOs
Peng Cheng,
University of Surrey
Jean Chen, University of Surrey
ABSTRACT. This study examines earnings management behaviors of Chinese IPOs in the pre-IPO period. We argue that there are two ways for IPO firms to manipulate pre-IPO reported earnings: one is to manipulate discretionary accruals, and the other is to structure artificial operating RPTs (non-loan) with controlling shareholders to boost sales and/or profits. Besides accruals management, IPO firms structure a large percentage of operating RPTs with controlling shareholders in the pre-IPO period, which is positively associated with the operating performance of IPO firms. In the post-IPO period, controlling shareholders discontinue these RPT-based earnings management practices, and the positive relation between operating performance of IPO firms and the size of operating RPTs disappears. We further find that long-run IPO stock performance is positively associated with the change in operating RPTs from before to after the IPO (at 1% significance level).
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